Wednesday, January 13, 2010

Buffett the dividend investor

Warren Buffett is the most successful investor of our time. The student of legendary value investor Ben Graham took on value investing to a whole new level by transforming the small textile mill Berkshire Hathaway (BRK.A) into a diversified conglomerate with interests in insurance, utilities, jewelry sales, newspaper publishing and many others.

Buffett is a closet dividend investor. One aspect of Buffett’s value strategy that many investors seem to miss is the fact that the Oracle of Omaha is a fan of companies which distribute a portion of their excess earnings back to Berkshire. This allows Buffett to re-invest the proceeds into new companies, which lets him further compound his invested capital.

Most of the companies which Berkshire has invested have been characterized by having wide moats, or durable competitive advantages. This is also the foundation behind some of the best dividend stocks out there. Only a company with a strong competitive advantage could afford to raise prices to consumers, which translates into higher earnings and ultimately into long-term dividend growth. Not having a large need of capital infusions is another important aspect of strong dividend growers.

Looking at the current portfolio holdings of Berkshire Hathaway, there companies. Of them seven are dividend aristocrats, one is an international dividend achiever and almost all of the rest pay a dividend except for six companies. Even some of Buffett’s core holdings such as GEICO and General RE, which he has acquired, were members of the elite dividend achievers index.

Berkshire Hathaway is expected to make about $1.3 billion in dividends from its publicly traded holdings. In addition to that Berkshire is expected to earn fat dividends from its investments in preferred stocks in General Electric (GE) and Goldman Sachs (GS) as well.

A major tenet of Buffett’s investment philosophy is buying a holding through thick and thin forever. It is especially interesting to note how much income his investment in Coca Cola (KO) and the Washington Post (WPO) generate. Berkshire’s average cost basis in Coca Cola is $6.49/share. With an annual dividend of $1.64/share Buffett is generating an annual yield on cost of 25.3%. This means that every 4 years he gets paid exactly what he paid for the stock 20 years ago. Buffett’s basis in Washington Post is $6.15/share. With a current dividend of $8.60, Berkshire’s yield on cost is 139.80%.

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